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Bitfinex—one of the largest cryptocurrency exchange platforms in the world—is under investigation by the New York Attorney General (the “NYAG”) for allegedly violating New York securities law under the Martin Act.
On April 24, 2019, the NYAG obtained an ex parte order1 precluding Bitfinex, and its affiliated stablecoin firm Tether, from engaging in fraudulent conduct that violate New York’s General Business Law (“GBL”).2 The order also requires Bitfinex and Tether to turn-over documents related to NYAG’s investigation into Bitfinex’s allegedly fraudulent acts, such as commingling client and corporate funds, misleading clients about Tether’s cash reserves, and failing to disclose $850 million in losses. On May 13, 2019, both parties filed individual proposals outlining their respective positions about the full scope of the continuing preliminary injunction.3 However, the court has yet to rule on these proposals and has failed to specify when it plans to lift the injunction—creating more questions than answers.
The ex parte order stems from an investigation that the NYAG commenced in 2018 to determine whether Bitfinex and Tether were in compliance with New York securities and anti-fraud regulations. In its petition, the NYAG alleges that Bitfinex, along with its various subsidiary companies, engaged in numerous activities that put U.S.-based investors at risk.4
First, “at no point known to NYAG has Bitfinex or Tether disclosed to clients that they have used third party ‘payment processors’ to handle client withdrawal, nor have they disclosed who those ‘payment process’ are.”5 In fact, the NYAG explained that Bitfinex and Tether have a history of troubled banking relationships, and struggled to secure a stable banking partnerships with credible institutions. For example, within a two year period, Wells Fargo dropped Bitfinex as a client and Noble Bank International ceased operations earlier this year.6
Second, the NYAG alleges that Bitfinex comingled over $1 billion in client and corporate funds with a Panamanian entity called Crypto Capital Fund Corp. (“Crypto Capital”).7 According to the NYAG, neither Bitfinex nor Tether ever entered into a written agreement with Crypto Capital. By failing to enter into a contractual relationship with its payment processor, Bitfinex and Tether allegedly put its client funds at risk.8
Third, Crypto Capital failed to process customer withdraw requests and/or refused to return funds to Bitfinex. “According to documents provided to NYAG by [Bitfinex], and based on statements made by counsel for [Bitfinex] to NYAG attorneys, an individual at Crypto Capital told the senior Bitfinex executive the reasons that funds totaling $850 million could not be return to Bitfinex was because the funds were seized by governmental authorities in Portugal, Poland, and the United States.”9 To make up for this loss of funds, the NYAG alleges that Bitfinex and Tether engaged in undisclosed, conflicted transactions to cover Bitfinex’s losses by transferring money out of Tether’s reserve funds. Due to this alleged cover-up, NYAG provides that Bitfinex misled its clients (including both clients of the Bitfinex trading platform and holders of tether) about the line of credit transaction to cover Bitfinex’s $850 million loss.
In its effort to obtain further information, NYAG’s ex parte petition10 sought a wide range of documents relating the allegations described above, including the following:
- All documents concerning Bitfinex users, accounts, clients, or customers that reside or are believed to reside, do business, or are believed to do business, in New York.
- All documents and communications regarding any transaction, of whatever nature, to loan, extend credit, encumber, pledge, or make any other claim, of any variety or description, on the U.S. dollar reserves underlying tethers to Bitfinex or any other entity.
- All documents and communications regarding any transaction, of whatever nature, to purchase, borrow, disperse, or loan tethers to or from third parties, including between Tether and Bitfinex, wherever located.
In response to the NYAG’s allegations, Bitfinex issued a press release on its website, providing that “[t]he New York Attorney General’s court filings were written in bad faith and are riddled with false assertions, including as to a purported $850 million ‘loss’ at Crypto Capital.”11 The press release goes on to provide that “Bitfinex and Tether will vigorously challenge this, and any and all other actions, by the New York Attorney General’s office.”12
On April 30, 2019, Bitfinex and Tether moved to vacate the ex parte order on three grounds:13
- Bitfinex and Tether argued that, as a preliminary matter, the NYAG failed to articulate that tethers qualify as securities or commodities covered by the Martin Act, which is a threshold to determine whether the NYAG has jurisdiction.14
- They claimed that the NYAG failed to use the correct preliminary injunction standard that is generally used for Martin Act cases.
- Bitfinex and Tether further argued that a preliminary injunction is not the proper remedy in this case because it is “hugely disruptive” in light of the fact that it freezes over $2 billion of Tether’s reserves.
Court Order to Limit Scope of Document Request
According to media sources, on May 6, 2019, the court ordered Bitfinex to turn over documents relating to the alleged $850 million tether-backed loan Bitfinex secured to cover up losses—with one caveat—the parties provide either joint or individual proposals outlining the scope of the injunction.15 While this court order has not been made public, it has been reported that Judge Cohen characterized NYAG’s document request as both “amorphous and endless.”16 The court further addressed the issue of whether the NYAG has jurisdiction to bring claims against Bitfinex since the Martin Act only applies to “securities and commodities.”17 The court explained that while the issue of whether Bitfinex is subject to the Martin Act is a threshold question, “[a]s a law enforcement agency it doesn’t seem really out of bounds to just probe whether an otherwise unregulated business involves securities which are subject to the Martin Act.”18 On May 13, 2019 both parties filed individual proposals19 explaining their positions about the scope of the injunction, including the length of time the NYAG needs to conduct their investigation and the scope of discovery. The court has not ruled on these proposals and has failed to provide a clear date for when it plans to lift the preliminary injunction.
The NYAG investigation raises concerns about Bitfinex and its ability to operate a virtual currency exchange platform that complies with New York regulations. The investigation also calls into question Tether’s stablecoin, touted as being pegged to the U.S. dollar. While there are many questions left unanswered, New York regulators continue to flex their muscle in the cryptocurrency arena.
1. See Ex Parte Order Pursuant to General Business § 354, Supreme Court of the State of New York, County of New York, Index No.: 450545/2019.
2. New York's Martin Act, New York General Business Law § 352 et seq.
3. OAG’s Correspondence to Judge Joel M. Cohen, In the Matter of iFinex, Inc., et al., Index No. 450545/2019 and Respondent’s Letter Regarding Proposed Form of Order on Motion to Vacate or Modify, In re Letitia James v. iFinex Inc., et al., Index No.: 450545/2019 (N.Y. Sup. Ct.) Proposed Order on Motion to Vacate or Modify (Motion Seq. 002).
4. See James v. iFINEX INC. et al., Affirmation of Brian M. Whitehurst In Support of NYAG’s Ex Parte Application for an Order Pursuant to General Business Law § 354, Supreme Court of the State of New York, County of New York, Index No.: 450545/2019.
11. See Announcements: Bitfinex Responds to New York Attorney General’s Actions, Bitfinex (April 26, 2019).
13. See James v. iFINEX INC. et al., Respondents’ Reply Memorandum of Law in Further Support of their Motion, by Order to Show Cause, to Vacate, or Modify the April 24, 2019, Ex Parte Order, Supreme Court of the State of New York, County of New York, Index No.: 450545/2019.
14. Under the Martin Act, the NYAG’s office can regulate securities and commodities, or the venues where securities and commodities are traded.
15. See Nikhilesh De, Judge Asks NYAG to Narrow Scope of “Amorphous” Bitfinex Document Request, Coindesk (May 6, 2019).
19. For a more comprehensive discussion about the proposed scope of discovery, please refer to OAG’s Correspondence to Judge Joel M. Cohen, In the Matter of iFinex, Inc., et al., Index No. 450545/2019 and Respondent’s Letter Regarding Proposed Form of Order on Motion to Vacate or Modify, In re Letitia James v. iFinex Inc., et al., Index No.: 450545/2019 (N.Y. Sup. Ct.) Proposed Order on Motion to Vacate or Modify (Motion Seq. 002).